A recent recovery in China's residential property market has reignited worries for many that the country's housing bubble is still expanding. However, compared to the residential property market, the commercial real estate market presents a far greater risk to the nation's economy and urgently calls for the attention of regulators.
After the government introduced restrictions on home purchases in many of China's urban centers, the commercial property market experienced a sudden surge in transaction volume. According to the National Bureau of Statistics, investment in office buildings and retail properties grew by 43.4 percent and 34.2 percent year-on-year respectively in the first quarter of 2012, outpacing the 19 percent growth in investment in residential property seen during the same period.
For the country's largest property developers, the commercial property market, which has evaded many of the restrictions imposed on residential housing, is just another place to speculate.
Currently, the average rental yield in the commercial real estate market is about 3 percent, much lower than the 6 percent interest most developers are paying on the loans to build up these properties. Also, with China's economic growth stalling, rents for commercial spaces will probably remain weak in the coming future. But rather than making money on commercial properties now though, it is clear that developers are most likely buying low with the hopes of selling, or renting, high later on.
This kind of speculative behavior has already driven up prices in the market for commercial space. In June, a Shanghai-based investment firm bought a commercial property in the city's suburbs for 175 million yuan ($27 million), 435.5 percent more than the property's starting bid.
The runaway growth now seen in the commercial property sector actually presents more of a danger to the country than the expansion previously witnessed in the residential market. Home prices, which are highest in first-tier cities, are basically supported by an enormous and steadily growing demand. In the process of urbanization, more people are moving to cities and as Chinese people get richer, they want to live in better homes. It is their need, in large part, that props up demand for residential space and makes the housing market less likely to collapse.
Demand in the commercial market, on the other hand, is largely influenced by the country's economic growth. When the economy is weak, companies no longer have as much need to rent space for business and rents will fall accordingly.
Once the bubble in the commercial sector bursts, and it eventually will, the credit real estate companies drew to develop these properties will turn into bad loans and damage the country's banking system.
The government needs to strengthen its supervision in the commercial property market and issue policies to curb irrational investment. For example, it should lift risk weighting on loans for commercial property development to discourage banks away from financing such projects.
